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The Long and Short of Convera

A stand-off between long and short investors is forming around search-software maker Convera Corp. (Nasdaq: CNVR). From Jun. 15 to Nov. 15, the Vienna, Va.-based company's stock price rose 222% to $14. During the same period, short interest in the stock jumped 187% to 5.2 million shares, or 15% of the company's float--not a huge chunk, but a hefty increase. Clearly, this is becoming a stock that investors either love or love to hate.

For several months, Convera has been talking up a so-called vertical search engine, which it launched on Nov. 1. The product blends "a company's internal content with filtered web content to provide more relevant results and deliver vertical views of the web for branded websites," says this Financial Times story. Based on the premise that most people look only at the first page of search results, Convera's search engine "reaches down into the unread pages" and "retrieves and categorizes information that readers would have otherwise missed," says Convera CEO Patrick C. Condo in this press release. The company claims its engine has already indexed 4 billion Web pages, 500 million images, 20 million audio files, and 5 million videos.

Convera's search engine is based on the company's Excalibur technology, which has been around for about 15 years and is used inside U.S. government agencies and, to a lesser extent, corporations. Because of the secretive nature of those outfits--the CIA is a big customer--information about Convera's customers is hard to come by. In the quarter ended Jul. 31, sales to the government totaled $5.5 million, or 71% of Convera's overall revenues. One customer accounted for 32% of those sales; another accounted for 16%. If, say, a cut in the federal budget had caused those customers to cancel their orders, Convera's revenues for the quarter would have dropped by nearly half.

And the revenues were small to begin with. During the quarter, Convera brought in $7.8 million. That's a 54% increase from last year, but for the first half of this year, revenues are down 2% from last year. Also in the first half, gross margins expanded 5% and net losses shrank 79% from last year. But Convera funded its operations during the period with $5.5 million from its coffers--an improvement from last year, but negative cash flow nonetheless.

The cash burn was mitigated by a $28.8 million private placement in the second quarter. The investors were fund manager Legg Mason Capital Management and investment bank Allen & Co., whose chairman, Herbert A. Allen, is a director at Convera. Allen & Co. was the largest shareholder of Convera's predecessor, Excalibur Corp., which merged with Intel Corp.'s interactive media division in 2000 to form Convera. Allen & Co. currently owns 26% of the resulting company.

Convera's chairman, Ronald J. Whittier, headed Intel's interactive media division before the merger. Upon closing the deal, he left Intel a stock-option millionaire after 30 years at the chipmaker. Incidentally, Whittier's son, John Whittier, was managing partner at the Wood River hedge fund, which went into receivership this fall after being sued for fraud by the Securities and Exchange Commission (the case is pending). It's unclear whether Wood River ever owned any Convera stock. Other hedge funds with similar strategies--including TCS Capital Management, Coghill Capital Management, and Ashford Capital Management--are among Convera's largest shareholders.

So, is Convera a short or long investment? That depends on whether you believe in the promise of what is essentially a speculative startup, albeit a 15-year-old one. Convera says that more than 200 prospective customers have been test-driving its new search engine. Perhaps we'll learn whether any of those prospects have plunked down cash when the company reports third-quarter earnings on Thu., Dec. 1. The investment from Legg Mason is certainly an endorsement, though it remains to be seen whether Legg's hot streak will continue this year. One thing's for sure: with giants like Microsoft, Google, and Yahoo fighting an epic war for the search market, little booty will remain for small fry.